ADMINISTRATIVE NOTICE 94­02





SUBJECT:	Property Tax -- State Tax Commissioner's Policy Statement for the Determination of the Capitalization Rates for Producing Coal, Oil and Gas, Other Mined Minerals, and Managed Timberland for Property Tax Purposes for Tax Year 1994, Pursuant to §
110-1H-8, §
110-1I-4.1.9, §
110­1J­4.7 and §
110-1K-4.1.8.

	On June
29, 1993, the Department of Tax and Revenue filed valuation variables to be used in conjunction with legislative regulations for the appraisal of natural resource properties.  (See:  §§
110 CSR 1-H, 1-I, 1-J, and 1-K)  This notice will address one of the variables, the capitalization rate, setting forth the generally accepted appraisal procedures used in developing the respective rates and in applying the rates to income streams generated by natural resource properties.  To this end, this notice will discuss development of industry capitalization rates for producing coal, oil and gas, other mined minerals, and managed timberland.

	DISCUSSION

	The International Association of Assessing Officers text "Property Appraisal and Assessment Administration, 1990, defines a capitalization rate as:  "Any rate used to convert an estimate of income to an estimate of market value; the ratio of net operating income to market value."  In other words a rate used to convert an estimate of future income into an estimate of present value.

	Generally, there are three (3) components that must be considered and if appropriate developed and included in an overall capitalization rate.  These components are:  the discount component, the recapture component, and the property tax component.  The development of each of these three
(3) components will be discussed in the remainder of this Notice.

	DISCOUNT COMPONENT

	Of the three (3) generally accepted methods of estimating a discount component, the bands-of-investment method and the summation method have received primary consideration.  Consideration was given to use of the comparison method; however, the Department is of the opinion that the bands-of-investment and summation methods are the more appropriate methods to employ for producing coal, oil and gas, and other mined minerals properties as they lend themselves more readily to the conversion of the equity rate portion of the discount component to a pre-tax rate.  In this regard the first step is to construct a capital structure.  The capital structure of an industry depicts typically the sources of capital financing (i.e.:  what portion of the total capital financing is raised through debt and through equity financing).

	The Department developed an average industry capital structure based on mining, oil and gas, and timber industries as grouped in Moody's Industrial Manual, 1992, and Moody's Handbook on Common Stocks, Spring edition 1993.  The capital structure was segregated into percentages of capital financing generated through debt and through equity financing in order to develop a profile for typical leveraging characteristics by type industry.  (Equity financing represents capital acquired through sale of stock and earnings retention and debt financing represents capital acquired through issuance of instruments of debt.)

	Once the capital structure had been established a return on investment is developed for each financing band.  The Department analyzed stock growth and dividend yield of companies grouped by industry in Moody's Handbook on Common Stocks in order to develop a return by type industry for common stocks.  This "after-tax" return was then adjusted to a "pre-tax" return where applicable and used in developing the equity portion of the discount component.

	The debt return for the debt finance band was established, for each industry, through analysis of loan rates extracted from questionnaires received from lending institutions.  Once a safe rate and a risk rate is developed from the previously mentioned analysis, a management rate (for management of investment portfolios) and a nonliquidity rate (time required to sell the investment) are estimated.  A synthesis of these rates (as illustrated in Attachment I) is then used to develop the discount component.

	RECAPTURE COMPONENT

	The discount component previously discussed provides an investor with a rate of return-on-investment (interest).  The second capitalization rate component, recapture, provides the investor with a return-of-investment (principal i.e.:  provides an estimate of return necessary for the investor to recovery the principal invested).  Once a capitalization rate has been developed for coal, oil and gas, and other mined minerals properties, the income series is discounted to present worth through selection of a multiplier(s) from a standard mid-year life Inwood table (see Attachment II).  The Inwood table has a factor for recapture built into the table coefficients thus removing the need to separately accommodate for recapture in the capitalization rate.

	PROPERTY TAX COMPONENT

	The third component, property taxes, was derived by multiplying the assessment rate by the statewide average of tax rates on Class III property.  Department research indicates that in addition to royalty rates negotiated in producing coal property leases, property taxes are paid by the coal producer.  Thus the capitalization rate for producing coal properties does not contain a property tax component as the income stream does not contain income to be used to pay property taxes.

	APPLICATION

	The summation of the previously discussed components (i.e.:  discount, recapture, and property tax components) yields a reasonable estimate for the overall capitalization rate.  The overall capitalization rate is used to select the factor(s) from a standard mid­year life Inwood table (i.e.:  present worth of one
(1) per period) that converts the income stream(s) into an estimate of present worth.

	The Bands-of-Investment and summation techniques were employed when developing discount rates for producing coal, oil and gas, and other mined mineral properties.  Likewise a combination of the bands-of-investment technique and the summation technique was employed in developing a discount rate for managed timberland properties.  An adjustment was then made to the managed timberland discount rate to remove the effects of inflation as the income stream developed for managed timberland is a noninflating perpetual (80 year) income series.  

	For more information concerning the development of capitalization rates for producing natural resource and managed timberland properties see 110
CSR
1-H, 1-I, 1-J, and 1-K, or contact the Department of Tax and Revenue at (304)
558-3940.

						James H. Paige III
						Secretary
						Department of Tax and Revenue

						Issued:  January 10, 1994

Department of Tax and Revenue
Property Tax Division
P. O. Box 2389
Charleston, WV  25328-2389
Operator on Duty 8:30 am - 4:00 pm
Monday through Friday
Phone:  (304) 558-3940
FAX:    (304) 558-2324














	A.  COAL PROPERTIES SURVEY






























							May 31, 1993
							James H. Paige III
							Secretary/Tax Commissioner
							Department of Tax and Revenue
1.	Capitalization Rate Survey and Results.

		In developing a capitalization rate for use in valuing income producing properties, consideration should be given to the three approaches generally considered in estimating a discount rate.  However, due to the limited amount of sales involving producing properties, the Bands-of-Investment and the summation techniques will be utilized.

	Summation Technique

	(a)	Safe Rate - 90-day Treasury Bills

			January - December 1992  =  3.460%
			January - December 1991  =  5.421%
			January - December 1990  =  7.498%

	(b)	Risk Rate

		1.	Debt - interest differential between Loan Rates and 90-day Treasury Bills.

				Loan Rates *			Risk Rate

			   1992  -   9.605%			  6.145%
			   1991  -  10.944%			  5.523%
			   1990  -  12.445%			  4.947%

			* From Questionnaire

		2.	Equity - differential between Equity Rates and 90­day Treasury Bills.

			    Equity Rates *			   Risk Rate

			   1992  -  13.50% ¸ (1-.27) =    15.033%
			   1991  -  14.50% ¸ (1-.27) =    14.442%
			   1990  -  14.50% ¸ (1-.27) =    12.365%

			* Moody's Handbook on Common Stocks Analysis

		3.	Risk Rate - Composite of Loan and Equity Rates weighted by industry estimated capital structure.*

		Equity Rates		Debt Rate		Composite Risk Rate

	    1992  -  9.020%		  2.458%            11.478%
	    1991  -  8.665%		  2.209%            10.874%
	    1990  -  7.419%		  1.979%             9.398%

			* Debt Equity Ratio = 40% Debt - 60% Equity
	(c)	Non-Liquidity Rate - interest differential between 90-day Treasury Bill rates and one year Treasury Bill rates which reflect time necessary to sell active properties.

		1 Yr.		3 Mth.	 Non-Liq.
		T-Bill	-	T-Bill  =  Rate  

		January-December 1992	=	3.757%	-	3.460%	=  .297%
		January-December 1991	=	5.531%	-	5.421%	=  .110%
		January-December 1990	=	7.363%	-	7.498%	= (.135%)

	(d)	Management Rate - charges for management of investment portfolios (from questionnaire).

		Rates:	(1)  5% of gross income
				(2)  $5/$1000 of principal or .500%


	Capitalization Rate  (Coal)

							1992		 1991	 1990
		Safe Rate				3.460	 5.421     7.498
		Risk Rate			    11.478	10.874     9.398
		Non-Liq. Rate			 .297	  .110      .000
		Mgmt. Rate		      .500	  .500	  .500
						    15.735	16.905	17.396
	   * Weight			   X  .40 	X .30 	X .30 
						     6.294	 5.072	 5.219

			Weighted Total  =  16.585%	Round to 16.50%

	   *	The valuation of an active coal property is dependent on the weighted average of the past three years of production.  Therefore, the capitalization rate will be estimated in the same manner.












	B.  OIL AND GAS PROPERTIES SURVEY






























							May 31, 1993
							James H. Paige III
							Secretary/Tax Commissioner
							Department of Tax and Revenue
1.	Capitalization Rate Survey and Results.

		In developing a capitalization rate for use in valuing income producing properties, consideration should be given to the three approaches generally considered in estimating a discount rate.  However, due to the limited amount of sales involving producing properties, the Bands-of-Investment and the summation techniques will be utilized.

	Summation Technique

	(a)	Safe Rate - 90-day Treasury Bills

			January - December 1992  =  3.460% ¸ (1-.95) = 3.642



	(b)	Risk Rate

		1.	Debt - interest differential between Loan Rates and 90-day Treasury Bills.

				Loan Rates *			Risk Rate

			   1992  -   9.630%		  6.170% ¸ (1-.95) = 6.495

			* From Questionnaire


		2.	Equity - differential between Equity Rates and 90­day Treasury Bills.

			    Equity Rates *			Risk Rate

			   1992  -  13.00% ¸ (1-.37) = 17.175%

			* Moody's Handbook on Common Stocks Analysis


		3.	Risk Rate - Composite of Loan and Equity Rates weighted by industry estimated capital structure.*

		Equity Rates		Debt Rate		Composite Risk Rate

	    1992  - 8.588%	  	  3.248%			 11.836%

			* Debt Equity Ratio = 50% Debt - 50% Equity
	(c)	Non-Liquidity Rate - interest differential between 90-day Treasury Bill rates and one year Treasury Bill rates which reflect time necessary to sell active properties.

		1 Yr.		3 Mth.	 Non-Liq.
		T-Bill	-	T-Bill  =  Rate  

		January-December 1992	=	3.757%	-	3.460%	=	.297%



	(d)	Management Rate - charges for management of investment portfolios (from questionnaire).

		Rate:	.500%  



	(e)	Property Tax Rate - sixty percent (60%) of the Statewide average of tax rates on Class
III properties.

		1992  =  60% of   2.51    =    1.506  %




	Capitalization Rate  (Oil/Gas)

							1992
		Safe Rate			=	 3.642
		Risk Rate			=	11.836
		Non-Liq. Rate		=	  .297
		Mgmt. Rate		=	  .500
		Property Tax Rate	=	 1.506
							17.781  = 1992 Capitalization Rate

							17.75% (Rounded)














	C.  OTHER ACTIVE NATURAL RESOURCE
	PROPERTIES SURVEY






























							May 31, 1993
							James H. Paige III
							Secretary/Tax Commissioner
							Department of Tax and Revenue
1.	Capitalization Rate Survey and Results.

		In developing a capitalization rate for use in valuing income producing properties, consideration should be given to the three approaches generally considered in estimating a discount rate.  However, due to the limited amount of sales involving producing properties, the Bands-of-Investment and the summation techniques will be utilized.

	Summation Technique

	(a)	Safe Rate - 90-day Treasury Bills

			January - December 1992  =  3.460%
			January - December 1991  =  5.421%
			January - December 1990  =  7.498%

	(b)	Risk Rate

		1.	Debt - interest differential between Loan Rates and 90-day Treasury Bills.

				Loan Rates *			Risk Rate

			   1992  -   9.467%			  6.007%
			   1991  -  12.893%			  7.472%
			   1990  -  12.250%			  4.752%

			* From Questionnaire

		2.	Equity - differential between Equity Rates and 90­day Treasury Bills.

			    Equity Rates *			Risk Rate

			   1992  -  13.50% ¸ (1-.27) =  15.033%
			   1991  -  14.50% ¸ (1-.27) =  14.442%
			   1990  -  14.50% ¸ (1-.27) =  12.365%

			* Moody's Handbook on Common Stocks Analysis

		3.	Risk Rate - Composite of Loan and Equity Rates weighted by industry estimated capital structure.*

		Equity Rates *		Debt Rate		Composite Risk Rate

		1992	-  9.020% 	  2.403%	  =		 11.423% 
		1991  - 8.665%		  2.989%    =		 11.654%
	    	1990  - 7.419%		  1.901%    =		  9.320%

			* Debt Equity Ratio = 40% Debt - 60% Equity
	(c)	Non-Liquidity Rate - interest differential betweeS 90-day Treasury Bill rates and one year Treasury Bill rates which reflect time necessary to sell active properties.

						     1 Yr.     3 Mth.     Non-Liq.
						     T-Bill -  T-Bill  =    Rate  

		January-December 1992	=	3.757%	-	3.460%	=     .297%
		January-December 1991	=	5.531%	-	5.421%	=     .110% 
		January-December 1990	=	7.363%	-	7.498%	=    (.110%)
		

	(d)	Management Rate - charges for management of investment portfolios (from questionnaire).

		Rates:	(1)  5% of gross income
				(2)  $5/$1000 of principal or .500%


	(e)	Property Tax Rate - sixty percent
(60%) of the statewide average of tax rates on Class
III properties.
		
		1992  =  60% of   2.51      =    1.506   %
	
		1991  =  60% of   2.51      =    1.506   %

		1990  =  60% of   2.47      =    1.482   %





	Capitalization Rate  (Other Natural Resources)

						1992		1991		1990				Safe Rate			3.460	5.421	7.498	
		Risk Rate		    11.423    11.654	9.320
		Non-Liq. Rate		 .297	 .110	 .000
		Mgmt. Rate		 .500	 .500	 .500
		Property Rate Tax	1.506	1.506	1.482
            			    17.186    19.191    18.800
	  *	Weight		    X.40      X .30 	X.30 
						6.874	5.757%	5.640%

		Weighted Total  =  18.271%	Round to 18.25%

	   *	The valuation of an active natural resource property is dependent on the weighted average of the past three years of production.  Therefore, the capitalization rate will be estimated in the same manner.












	D.  TIMBERLAND PROPERTIES SURVEY






























							May 31, 1993
							James H. Paige III
							Secretary/Tax Commissioner
							Department of Tax and Revenue
	1.	Capitalization Rate Survey and Results

		A single Statewide capitalization rate for timberland has been determined using the following format(s):

	  -	The rate will be based on the assumption of a level, terminal (80 year) income series.

	  -	The rate, because of the use of a level, non-inflationary income series, will be void of any expected inflation rate.

	  -	The rate will be determined by the summation technique.

	Safe Rate:
		(Long Term U. S. Securities)
							(30
yr. T-Bills)

	

		1992	=	7.667	X	5/15	=	2.556
		1991	=	8.136	X	4/15	=	2.170
		1990	=	8.608	X	3/15	=	1.722
		1989	=	8.449	X	2/15	=	1.127
		1988	=	8.959	X	1/15	=	0.597
		
											8.172%

	Illiquidity Rate:
		(12 Mth. T-Bills vs. 3 Mth. T-Bills)

	1992	3.757	-	3.460	=	.297	X	5/15	=	.099
	1991	5.513	-	5.412	=	.110	X	4/15	=	.029
	1990	7.363	-	7.498	=	.000	X	3/15	=	.000
	1989	7.949	-	8.123	=	.000	X	2/15	=	.000
	1988	7.130	-	6.685	=	.445	X	1/15	=	.030
	

											.158%

	Risk Rate:
          Debt	(Long Term Loan Rates - Safe Rate)

	1992	9.711	-	7.667	=	2.044	X	5/15	=	.681
	1991  10.506	-	8.136	=	2.370	X	4/15	=	.632
	1990	13.108	-	8.608	=	4.500	X	3/15	=	.900
	1989	12.363	-	8.449	=	3.914	X	2/15	=	.522
	1988	10.230	-	8.959	=	1.650	X	1/15	=	.110
	

										2.845



	Equity:	(Equity Rate - Safe Rate)

	1992	13.00	-	7.667	=	5.333	X	5/15	=	1.778
	1991	13.50	-	8.136	=	5.364	X	4/15	= 1.430
	1990	13.50	-	8.608	=	4.892	X	3/15	=  .978
	1989	13.50	-	8.449	=	5.051	X	2/15	=  .673
	1988	13.50	-	8.959	=	4.541	X	1/15	=  .303
									  5.162
									

	Risk Rate	(Debt and Equity Rates weighted by industry         Estimated Capital Structure*)

			Debt			2.845      X	.45	  = 1.280	 
			Equity		5.162      X	.55	  = 2.839
				Composite Risk Rate				     4.119%

	* Capital Structure:  45% Debt; 55% Equity


	Management Rate:   							     .500%                              

	Property Tax Rate:  60% of Class III Rate

	1992	1.506	X	5/15	=	.502
	1991	1.506	X	4/15	=	.402
	1990	1.482	X	3/15	=	.296
	1989	1.482	X	2/15	=	.198
	1988	1.476	X	1/15	=	.098
	
										   1.496%


	Inflation Rate:  Bureau of Labor Statistics

	1992	2.9	X	5/15	=   .967
	1991	3.1	X	4/15	=   .827
	1990	6.1	X	3/15	=  1.220
	1989	4.6	X	2/15	=   .613
	1988	4.4	X	1/15	=   .293
	
										 (3.920)

	Capitalization Rate:  Managed Timberland    =  10.525%

							Rounded to    10.50%

	Midyear Factors for Present Worth of 1 and
	Present Worth of 1 Per Annum


Percent 16.50

				   Present Worth		    Present Worth
Period			        of 1    		    of 1 Per Annum


	1	0.926	0.926
	2	0.795	1.722
	3	0.683	2.404
	4	0.586	2.990
	5	0.503	3.493
	6	0.432	3.925
	7	0.371	    4.296
	8	0.318	4.614
	9	0.273	4.887
	10	0.234	5.121
	11	0.201	5.322
	12	0.173	5.495
	13	0.148	5.643
	14	0.127	5.770
	15	0.109	5.880

	Midyear Factors for Present Worth of 1 and
	Present Worth of 1 Per Annum


Percent 17.75

				   Present Worth		    Present Worth
Period			        of 1    		    of 1 Per Annum


	1	0.922	0.922
	2	0.783	1.704
	3	0.665	2.369
	4	0.564	2.933
	5	0.479	3.413
	6	0.407	3.820
	7	0.346	4.166
	8	0.294	4.459
	9	0.249	4.709
	10	0.212	4.920
	11	0.180	5.100
	12	0.153	5.253
	13	0.130	5.383
	14	0.110	5.493
	15	0.094	5.586
	Midyear Factors for Present Worth of 1 and
	Present Worth of 1 Per Annum


Percent 18.25

				   Present Worth		    Present Worth
Period			        of 1    		    of 1 Per Annum


	 1	 .920	0.920
	2	 .778	1.697
	3	 .658	2.355
	4	 .556	2.911
	5	 .470	3.381
	6	 .398	3.779
	7	 .336	4.115
	8	 .284	4.400
	9	 .241	4.640
	10	 .203	4.844
	11	 .172	5.016
	12	 .145	5.161
	13	 .123	5.284
	14	 .104	5.388
	15	 .088	5.476